Monday, April 04, 2011

Benjamin Grahams principles to Invest

The famous investment guru, Benjamin Graham, once said, ‘Investment is most intelligent when it is most businesslike.’ Yet, if one were to take a look at the profile of an average investor in the equity markets, there emerges a very capable businessman who has gained success in his own business but has operated in the markets with complete disregard of all sound business principles of business. In this regard, let us take a look at some of these principles that have been completely violated in the markets, but if followed with discipline, would result into investors earning adequate returns.

The first of these principles, as given by Graham, is to ‘know what you are doing.’ This is similar to knowing your business. In the investing sense, this means that an investor should not try to make business profits out of his investments. More simplistically, this means that he should not try to earn returns in excess of normal interest and dividend income, unless he knows as much about his investments’ values as he would know about the value of his business. If he defies this basic principle, he is not an investor, but a speculator who is betting on his intuition without the adequate knowledge to back the same.

The second principle is ‘not letting anyone else run your business’ (stock market investment, in this sense) unless one is pretty sure of the integrity and ability (the management of a company or a mutual fund). This rule would help investors determine the conditions under which he entrusts his money for someone else to manage.

The third principle is for the investor to ‘undertake an investment only when a reliable calculation indicates that there is a fair chance for a reasonable return on the investment.’ More simply, based on this principle, an investor’s strategy for earning profits should be based on careful calculations and research rather than plain optimism. Not following this principle is equivalent to putting your principal to a considerable risk.

And finally, the most important principle is to ‘have the courage of knowledge and experience.’ This is to say that once you have arrived at a conclusion from the facts and careful calculations, you need to act on the same caring not much about what everyone else is doing (or betting on). This is discipline, the most important rule at the root of sound investing.

By following these principles and not giving in to greed/fear that rising/falling markets bring with them, you can ensure that the consequences of your mistakes would never be disastrous. And more importantly, you will not blame the stock markets for your losses. When that happens, no matter what the markets throw at you, you will always be able to say with much confidence.

Source : Equitymaster

8 investing tips ....

Equities: 8 investing tips

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on

Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals. Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back.
It is apt to note here what Warren Buffet, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, “It means we miss a lot of very big winners but it also means we have very few big losers…. We’re perfectly willing to trade away a big payoff for a certain payoff”.

Avoid trading/timing the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers’ end at the end of the day. In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again. In Benjamin Graham’s (pioneer of value investing and the person who influenced Warren Buffet) words, “Basically, price fluctuations have only one significant meaning for the ‘true’ investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market”.

Avoid actions based on rumours/sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investors’ portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffet, “Be fearful when others are greedy and be greedy when others are fearful”.

Avoid emotional attachment/averaging: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price. However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company’s performance may improve for the better and the stock would provide an opportunity to exit at higher levels. Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffet’s words, “Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.

Avoid over-leveraging: This behaviour is typical in times of a bullrun when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards). However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements. In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

Keep Margin of Safety: In Benjamin Graham’s words, “For ordinary stocks, the margin of safety lies in an expected ‘earning power’ considerably above the interest rates on debt instruments”. However, having a stock with a high margin of safety is no guarantee that the investor would not face losses in the future. Businesses are subject to various internal and external risks, which may affect the earnings growth prospects of a company over the long-term. But if a portfolio of stocks is selected with adequate margin of safety, the chances of losses over the long term are minimised. He further points out, “while losing some money is an inevitable part of investing, to be an ‘intelligent investor,’ you must take responsibility for ensuring that you never lose most or all of your money.”

Follow research: The upswing in the stock markets attracts many retail investors into investing into equities. However, picking fundamentally strong stocks is not an easy task. In fact, it is even more difficult to identify a stock in a bullish market, when much of the positives are already factored into the stock price, making them an expensive buy. It is very important to understand here that owning a stock is in effect, owning a part of the company. Hence, a detailed and thorough research of the financial and business prospects of the company is a must. Given the fact that on most occasions, research is influenced by vested interests, the need of the hour is unbiased research. Information is power and investors need to understand that unless impartially represented (in the form of research) it could be misleading and detrimental in the long run.

Invest for the long-term: Short-term stock price movements are affected by various factors including rumours, sentiments, market perception, liquidity, etc, however, in the long-term, stock price tends to align themselves with its fundamentals. Here it must be noted what Benjamin Graham once said, “…in the short term, the market is a ‘voting’ machine (whereon countless individuals register choices that are product partly of reason and partly of emotion), however in the long-term, the market is a ‘weighing’ machine (on which the value of each issue (business) is recorded by an exact and impersonal mechanism).”
Of course, it must be noted that the above list is not exhaustive and there may be many more points that an investor needs to understand and follow in order to be a successful investor. Further, the above points are not just a read but needs to be practiced on a consistent basis. While making wealth in the stock markets was never an effortless exercise, it becomes all the more difficult when stock markets/stock prices are at newer highs.

Source : Equitymaster.com

Stock split ...... What's that?

Sure does sound funky. But a stock split happens quite often.
And, what it means is rather direct. Your stock actually gets split.
To understand what a stock split is and how it impacts you, read on.

  • First understand what a share is
Any business has a lot of assets: machinery, buildings, land, furniture, stocks, cash, investments. It will also have liabilities. This is what the company owes other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities. Take away the liabilities from the total assets, and you are left with the capital. Assets - Liabilities = CapitalCapital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital. This capital is subdivided into shares.
So if a company's capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore (10 million) shares of Rs 10 each. So, if you own 100 shares of Gujarat Ambuja Cement, for example, you own a very small part -- since Gujarat Ambuja has millions of shares -- of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.
  • How is this share valued?
If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.
When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock. So the price of Company X shares will go up and down depending on the demand for Company X stock.
If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).
If the number of shares in a company is multiplied by its market value, the result is market capitalisation.

  • Now you will understand what a stock split is
The face value of a company's shares may be Rs 100.The company may want to change the face value. So it will take one share of Rs 100 and make it two. So now, the face value of each share is Rs 50. If you owned one share, you will now own two. So basically, the number of shares have increased. But, the number of shareholders have not. The number of shareholders are the same. It is just that the number of shares they own has doubled.

  • Who will get the additional shares?
The company announces the split ratio on a particular date called the record date. All shareholders whose names appear on the company's records as on the record date will be eligible for the additional shares. A few weeks later, the shares will start trading ex-split on the stock exchanges.

  • How is it different from a bonus?
Earlier I had mentioned that cash reserves form part of the company's assets. Now when these reserves get large, the company may decide to convert it into shares. These shares are then given free of cost to the investors. So when you get a bonus, the number of shares you own increases at no cost to you.
A stock split is somewhat like a bonus in the sense that, when a Rs 10 stock is split into two Rs 5 shares, the number of shares you hold doubles at no cost to you. But that is where the similarity ends. A bonus is a free additional share. A stock split is the same share split into two.In a stock split, the number of shares increases but the face value drops (the face value never changes for a bonus shares). So a stock split is just a technical change in the face value of the stock. There is no other change in the company.

  • How does this impact you?
In one way, nothing has changed. It's like cutting an 8-inch pizza into 12 slices from four slices before. But, if you want to buy the shares of a company which are frightfully expensive, you can now buy them for less.
For example, the face value of the shares of Rs 100 will now be Rs 50 (above example). So, if the share was quoting at Rs 200 (when face value was Rs 100), it will now quote at Rs 100 (since the face value is now Rs 50).So, those who could not afford to buy the shares at Rs 200, may now be able to buy it at Rs 100. But this is just in theory. Chances are that instead of the stock quoting at Rs 100, it may quote at Rs 120. Sometimes, the stock price of a company goes up after a stock split because demand for those shares increase. More investors may want that stock since they can afford it. For instance, JB Chemicals & Pharma split the face vaue of its stock from Rs 10 to Rs 2, by a four for one split April 5. So for every one stock you held, investors got four new ones. What happened to the price of the stock? It was Rs 451 before the split and adjusted to Rs 90 after the split. The stock did go up, however, from around the Rs 400 level to Rs 451 before the split. Balrampur Chini's split the face value of its stock from Rs 10 to Rs 1 on March 23, sending its stock down from Rs 681 before the split to Rs 68 after it. The stock had moved up from Rs 637 to Rs 668 in the month before the split.The Gammon India stock split on March 15 led to the face value of the stock going down from Rs 10 to Rs 2. The stock was Rs 1,235 before the split, coming down to Rs 247 afterwards. It had moved up from around the Rs 870 level to Rs 1,235 a month before the split.
So do note, if you are an investor in the company, you have reason to celebrate when you get a bonus. No reason to celebrate when your stock is split.
But, if you want to buy more shares, then it is good news because now you will be able to afford them or at least get them cheaper.